The Kyoto Protocol is an inter- national treaty negotiated in 1997 to reduce emissions of carbon dioxide, methane and several other gases which absorb infrared radi- ation and may cause changes in the climate system. It has not yet been rat- ified, and with the U.S. decision in March 2001 to withdraw from the treaty its future appears uncertain. But many of the remaining parties, includ- ing Canada, have indicated a desire to press ahead with it. The future of Kyoto is a question now preoccupying environment ministries around the world.

The treaty requires participants to reduce emissions of carbon dioxide to about six per cent below 1990 levels by the year 2012. In Canada, emissions have risen since 1990 so the actual cut will have to be between 25 and 30 per cent. Since the main source of carbon dioxide is fossil fuel use, and CO2 can- not be ”œscrubbed” from emission streams the way smoke particulates can, this will require significant scaling back of energy consumption. The asso- ciated loss of GDP is typically estimat- ed at between zero and three per cent. Since the Protocol itself would not have much effect on atmospheric CO2 levels anyway, most signatories have been reluctant to implement it.

Into this discussion, David G. Victor, an analyst with the Council on Foreign Relations in New York, has lobbed a blunt message. The collapse of Kyoto is a matter of when, not if. In this short book he critiques the hasty process that led to the accord and out- lines its key internal contradictions. But despite the picture on the cover, his intent is not to leave scorched earth. He proposes what he believes could be a better alternative, based on a hybrid of economic instruments. Victor is right about Kyoto, but his alternative is not persuasive.

The book was written in the late fall of 2000 after unsuccessful talks on how to implement Kyoto were held at the Hague. The manuscript was com- pleted before the results of the U.S. Presidential election were known, so the U.S. withdrawal from Kyoto in March 2001 does not figure into the overall analysis. The book accurately predicts, however, some of the politics that did play out during the year after it was written. For instance, partici- pants in the Protocol sought, and received, permission to reduce their targets by counting ”œsinks”: the with- drawal of carbon dioxide from the atmosphere by the growth of trees and plants. Victor rightly points out that the accounting schemes for these cred- its are highly uncertain and likely to be matters of serious contention in years ahead.

But Victor’s main concern is the economic mechanism being proposed for implementing Kyoto. The treaty authorizes trading of carbon dioxide ”œcredits,” and many of the participat- ing countries (including Canada) con- sider the possibility of buying these credits on an international market to be essential to their willingness to par- ticipate. The problem, Victor argues, is that an international market for per- mits cannot be established: the legal institutions necessary to support it do not exist.

In a so-called ”œcap-and-trade” sys- tem, nations agree to an overall emis- sions target, then allow firms access to an international market in which they can trade their emission allowances. Under ideal conditions this would allocate abatement activity efficiently around the world. This cost-reducing option was key to securing broad par- ticipation. Without it the economic impacts of emission reductions soar to prohibitive levels.

But the cap-and-trade system has two major flaws. First, it assumes the presence of institutions of international law which in reality do not exist. Hence the permits being traded across borders are contracts that cannot be enforced. The sellers have an incentive to cheat on their own emission limits and buy- ers have no incentive to monitor seller behaviour. As a result the permits will likely be worthless before long.

Some proponents of Kyoto have argued that the credibility problem can be surmounted by imposing liabil- ity on either the buyer or the seller, so that if the credit turns out to be based on a false claim by the seller of having cut emissions, one party or the other will be responsible for purchasing a ”œlegitimate” credit to make up for it. Analysts at Resources for the Future in Washington, D.C. have argued that the seller ought to be held liable, and the threat of liability will induce hon- est accounting. Victor rightly points out, though, that this simply will not hold in the absence of strong interna- tional legal institutions that do not now exist and are not likely to exist any time soon.

The second major flaw of the cap- and-trade system is that, even if the contracts were viable, a conservative estimate puts the initial value of the emission allowances at about $US 2.3 trillion. And the allocations written into Kyoto make this a financial liabil- ity from the U.S. to Russia and the Ukraine. The U.S. has since pulled out, so this part of the argument loses some of its force. But the remaining coun- tries in Kyoto would face a similar problem: a somewhat smaller liability, still payable to Russia and the Ukraine. This is unlikely to be palatable to Western voters.

Nations do not have to engage in international permits trading, but domestic action is typically found to be at least twice as expensive. Some analysts had floated the idea of a coor- dinated tax system as an alternative. Under this scheme nations would agree on a common internal ”œcarbon dioxide tax” and keep the revenue nationally. Victor rightly points out that even if nations agree on such a mechanism, a country could easily dis- tort the rate with offsetting subsidies and hidden exemptions to secure a competitive advantage.

Beyond these problems, monitor- ing and enforcement are deal-breakers lurking in the background. Because Kyoto is a multi-gas treaty covering such things as methane, which is effec- tively impossible to measure and verify, the administration of targets is a more or less hopeless task. And no one is in a position to inflict penalties for non- compliance, unless some extremely complicated side deals get worked into the World Trade Organization discus- sions"an unlikely prospect.

As a means of improving the prospects of the treaty, Victor advo- cates dropping all gases from Kyoto except carbon dioxide. The point is valid in the sense that only CO2 emis- sions can realistically be measured. But he also points out that Kyoto-scale cuts will do ”œpractically nothing to slow global warming”"which is a stumbling block for any policy that attempts to address climate change through emission reductions.

Victor also proposes an alternative mechanism based loosely on a 1976 paper by economists Marc Roberts and Michael Spence. In their paper they looked at a theoretical problem in which a regulator must set up an emis- sions control policy without knowing in advance the abatement costs of the various sources. They proposed a trad- able permits system backed by a sub- sidy for holding excess permits and a fee for emitting more than one holds allowance for. If the regulator must put the policy in place on a one-shot basis and there is no possibility to revise it later, this hybrid system generates lower expected social welfare losses than a pure emissions trading system or emissions tax system.

The problem with using this pro- posal as a Kyoto alternative, though, is that it is still based on a permits trad- ing system. The only wrinkle is that governments offer ”œsafety valves” in the form of a price floor and ceiling in order to restrict the range of cost uncertainty. But implementing the hybrid permits scheme still presuppos- es that an international tradable per- mits regime can be established. As such it has all the flaws that, in Victor’s analysis, doom Kyoto.

Victor does not address some other pertinent problems with Kyoto or the hybrid system. For instance, he dis- misses the international ”œleakages” problem on the grounds that capital is generally immobile in response to dif- ferential environmental policy. This is true, but the ”œleakages” problem refers to the case in which emission reduc- tions in one region change interna- tional prices in such a way as to induce increased emissions in other regions. It is not primarily driven by capital mobility, but by relative changes in fuel prices between Kyoto participants and non-participants. Even without international capital mobility we will have a leakages problem.

The key to understanding the diffi- culties with Kyoto and its alternatives is stated"and then effectively dis- missed"in a single paragraph in the book. Victor dismisses those who focus on the ”œwrong factors”"such as that Kyoto’s costs far outweigh its environ- mental benefits. But why dismiss this point? It is the central point of the debate, to which all analyses eventually return. The enormity of the costs and the absence of any tangible benefits are points that Victor ultimately does admit. Once stated they sink any emis- sions reduction proposal just as neatly as Victor has sunk the Kyoto Protocol.